Market News

Brexit risk fails to deter BoE from rate hike

We think the next increase is likely to be in 2019.

02/08/2018

Azad Zangana

Azad Zangana

Senior European Economist and Strategist

Schroders

The Bank of England (BoE) has raised its main policy interest rate from 0.50% to 0.75% - its highest level since March 2009 and the first hike above the post-financial crisis level. The Bank backed away from raising rates in February owing to a significant slowdown in growth. However, data on retail sales and production have improved, which has allowed the Bank to proceed with a hike.

Brexit is the biggest risk for the UK economy and the BoE’s rate setters. We had assumed that the Bank may want to wait until November, when the likelihood of a Brexit deal would be clearer. Instead, the Bank has gambled, emphasising that the reactions of households and businesses to Brexit are more important than the outcome itself – suggesting that households and businesses may not respond.

The Bank also published its quarterly Inflation Report, which included analysis of equilibrium neutral interest rates (i.e. the level that will keep the economy neither too hot nor too cold). It concluded that the neutral rate has come down substantially since 1990 for many reasons including an ageing population, slower productivity growth and the nature of fiscal policy. In nominal terms, the BoE estimates the neutral long-term interest rate to be between 2-3%.

However, in the near-term, the neutral rate is lower due to short-term cyclical factors. We believe that this is a very dovish assessment of the current state of the economy, which may be why the pound has fallen since the announcement, while government bond yields have fallen (i.e. prices have risen).

The Bank has kept its forward guidance of slow and limited interest rate rises, with three rate hikes in three years broadly expected. We forecast two rate rises in the second half of 2019 but this is dependent on a smooth Brexit, the probability of which has been falling in recent weeks.

The opinions contained herein are those of the author and do not necessarily represent the house view. This document is intended to be for information purposes only. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Cazenove Capital does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. This does not exclude or restrict any duty or liability that Cazenove Capital has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Cazenove Capital is part of the Schroder Group and a trading name of Schroder & Co. Limited 12 Moorgate, London, EC2R 6DA. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. For your security, communications may be taped and monitored. 

Contact Cazenove Charities

Achieving your charity's investment objectives takes time and thought. To find out how we can help you please contact:

Giles Neville

Giles Neville

Head of Charities giles.neville@cazenovecapital.com
John Clifton

John Clifton

Business Development Manager john.clifton@cazenovecapital.com